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C O N F I D E N T I A L SECTION 01 OF 03 BAGHDAD 002107
SIPDIS
STATE PASS TO USAID, STATE PASS TO NEA-ROBERT SILVERMAN,
STATE PASS TO EB-DAS LARRY GREENWOOD/TOM ENGLE, TREASURY
PASS TO OLIN WETHINGTON
E.O. 12958: DECL: 05/19/2015
TAGS: ECONEFINPRELIZ
SUBJECT: DEPUTY FINANCE MINISTER AZEZ'S LAST WORDS ON
DISCUSSIONS WITH THE IMF, CBI, AND DEBT
Classified By: CLASSIFIED BY ECONOMIC MINISTER-COUNSELOR ANNE E. DERSE
FOR REASONS 1.4 (B) AND (D)
¶1. (SBU) SUMMARY. Deputy Finance Minister Azez Hassan said
Iraq's reporting on fiscal data to the International Monetary
Fund (IMF) has improved significantly and is now strong. MOF
is ready to close the books on 2004 and Azez said he expects
the Budget Department to finalize by the June 6 Article IV
consultations the fiscal data for at least the first two
months of 2005 and "probably" through the end of March. He
identified four key challenges to a successful Article IV
discussion and eventual negotiation of a Stand-By Arrangement
(SBA) in 2005: (1) Fuel subsidy reform; (2) Food subsidy
reform; (3) Reform of state-owned enterprises; and (4)
controlling inflation. Based on his knowledge of the new
cabinet members of the Iraq Transitional Government (ITG),
Azez is not optimistic that the first three reforms are
politically feasible. Azez said inflation would actually be
negatively impacted by the success of these reforms,
especially with the Central Bank's lack of effective monetary
policy tools. Azez's main concern, however, is that with his
forced resignation (septel) there is no one who can
competently manage Iraq's relationship with the IMF. Azez
also said he told new ITG Finance Minister Ali Allawi that
former FinMin and current Vice President Adil Mahdi needs to
be included in debt negotiations with Gulf creditors because
he laid down the current base. It is our impression from a
recent meeting with the Charge that Mahdi agrees with Azez.
END SUMMARY.
----------------------------------------
REPORTING ON 2004 AND FIRST QUARTER 2005
----------------------------------------
¶2. (C) Deputy Finance Minister Azez Hassan told us on May 16
that the Ministry of Finance (MOF) Budget Department was
finally prepared to close the books on 2004 fiscal data.
Azez said he worked closely with the IMF last month in
Washington to identify gaps in the MOF's first data
submission and his staff told him earlier in the day that the
data is now complete. In addition, Azez said he expects the
Budget Department to finalize by the June 6 Article IV
consultations in Bahrain the fiscal data for at least the
first two months of 2005 and "probably" through the end of
March. One significant factor missing from the 2005 data is
any information from the Kurdish Region. Prior to 2005, the
MOF treated the Kurdish Region as a transferred expenditure
from within MOF's budget. Thus, the transfer of funds from
the line item in the MOF budget to the Kurdish Region
(Suleymaniyah and Irbil, which also covers Dohuk) was the
only required reporting. According to Azez, the Kurdish
Region insisted the 2005 budget treat the Kurdish Region as
two independent spending units just like all of the line
ministries. As a result, the Kurdish Region is now required
to provide a detailed spending plan and report their
expenditures and revenues just like every other line
ministry. Azez said MOF has yet to receive any information
in 2005. (Note: We later learned that officials from the
Kurdish Region provided their detailed budget spending plan
for 2005 to MOF on May 16, but they have yet to report any
actual expenditure or revenue detail for 2004 or 2005. End
Note.) Azez agreed the Minister of Finance should contact
Kurdish leaders Massoud Barzani (KRG Prime Minister) and
Jalal Talabani (ITG President) in writing to formally request
the required expenditure information.
-------------------------------------
SBA IS DEAD WITHOUT FUEL PRICE REFORM
-------------------------------------
¶3. (SBU) Azez reiterated what we have heard from various
sources, including the IMF, in that unless the ITG acts on
fuel price reform there is no chance of an SBA. Azez said
the IMF expects ITG action on both the opening of the import
market to the private sector and the raising of domestic,
state-controlled prices for at least the two high-end
petroleum products (high octane fuel and low-sulfur diesel).
Azez said there are two views on how to raise prices: (1) one
shot with some sort of compensation or (2) gradually without
compensation. Azez favors the gradual approach without
compensation, which he said is the same approach favored by
the IMF. Azez said under the gradual approach, the goal
would be to eliminate the subsidy within two to three years.
(Note: Iraq's commitment to the IMF is to phase out the fuel
price subsidy by 2009. End Note.)
¶4. (C) Azez confirmed the Cabinet and National Assembly would
both have to approve any significant fuel price reform. He
is not optimistic about passing this reform in 2005 given the
current make-up of the ITG Cabinet. In particular, Azez is
concerned about the new ITG Minister of Oil, Ibrahim Bahr
Al-Uloum, who, according to Azez, was the main obstacle in
the Iraq Governing Council that prevented the Coalition
Provisional Authority from taking action on fuel price reform
back in February 2004. (Comment: In our initial discussion
with Bahr Al-Uloum (septel), he recognized that the ITG will
need to reform Iraq's fuel price subsidy system both for the
benefit of the Iraqi budget and the negotiation of an SBA
with the IMF, and the new Electricity Minister told us May 18
that Bahr Al-Ulooum supported the reform, as he does.
Finance Minister Allawi and Planning Minister Barham Saleh
are strongly in favor of significant reform. Prime Minister
al-Jafari's position remains tenuous. End Comment.)
--------------------------------------------
NEED AT LEAST A PLAN FOR FOOD AND SOE REFORM
--------------------------------------------
¶5. (C) Azez said he told Minister Allawi in a recent briefing
on commitments to the IMF that the ITG must at least approve
plans to address Iraq's food distribution system and
state-owned enterprises (SOEs). Azez did not know whether
the Privatization Commission established by former Prime
Minister Iyad Allawi still exists under the new government.
He was once again not optimistic about approval of either of
these reforms since he does not think the new Cabinet will
take the political risk.
------------------------------
INFLATION AND THE CENTRAL BANK
------------------------------
¶6. (SBU) Azez explained that the proposed fuel, food, and SOE
reforms would all have an inflationary effect on prices
(liberalization of fuel prices, monetization of food basket,
and privatization of SOEs). The Central Bank of Iraq (CBI)
does not have any working tools to manage inflationary
pressures, according to Azez. Azez said the IMF will
continue to look hard at inflation during the SBA
negotiations.
¶7. (C) KPMG is currently in Iraq attempting to finalize the
International Advisory and Monitoring Board (IAMB) audit on
the Development Fund for Iraq (DFI). The Ministry of Finance
has been working to identify discrepancies between the draft
IAMB audit and the Ministry's figures. Several of the
figures used by KPMG in the audit are the same figures
available to CBI from the Federal Reserve Bank in New York
(FRBNY). However, no one in the Central Bank, according to
Azez, would certify the DFI balances presented by KPMG. Azez
said the "records of the Central Bank are a shame -- what is
happening at the Central Bank is shameful". He wasn't sure
if the cause was incompetence or corruption. In reference to
the possibility of continuing to work on Iraq's debt
negotiations as an advisor to CBI, Azez responded that that
would be impossible; he "knows the inside((and) cannot stand
the CBI."
¶8. (C) In the context of discussing the extent of his
(former) responsibilities at MOF, Azez said the CBI recently
tried "in a devious way" to bring US dollars (USD) to Iraq
for the daily currency auction. The Minister learned of a
request for a USD 3 billion cash transfer from the FRBNY to
the CBI vault in Baghdad and called Azez for an explanation.
Azez said he was unaware of the transaction. He said he
immediately called Governor Shabibi to stop the transfer.
Azez found out the following day, May 15, that the Ministry
had requested a USD 2.3 billion cash transfer to the CBI
vault and the CBI requested an additional USD 700 million
cash transfer from the CBI's independent account in the
FRBNY. MOF officials explained to Azez that the transfer was
necessary to fund letters of credit (LCs) and to buy Iraqi
Dinar (ID) from the CBI for normal government operations.
Azez explained that he previously set up a system with the
CBI by which MOF would order the CBI to pay LCs directly out
of the DFI account in the FRBNY, rather than shipping cash to
Iraq then back out again to fund the LC. To fund normal
government operations, MOF should tell the CBI how many ID
are required and the CBI should provide them. CBI would then
simply transfer USD from the DFI account in the FRBNY to the
CBI account in the FRBNY to pay for the ID. MOF does not
need to transfer USD into Iraq. Rather, only CBI requires
USD for the daily currency auction. Azez said CBI "probably
wanted to make MOF pay for the cost" of transporting the USD
to Iraq.
------------------------------
VP MAHDI AND DEBT NEGOTIATIONS
------------------------------
¶9. (C) Azez told us that he told Allawi he "needs to include"
former FinMin and current Vice President Adil Mahdi in
negotiations with Gulf creditors. Azez said when Allawi
questions why, Azez said Mahdi "laid down the base."
Everyone in the Cabinet needs to be included in these
negotiations, according to Azez.
¶10. (C) VP Mahdi told the Charge in a May 12 meeting that
negotiations with the Gulf creditors is a "political isse".
He continued, "I don't think the Saudis want USD 800 million
from us(they want contracts, assistance, etc." Mahdi said
the ITG still needed to "start" negotiations with the Gulf
States. (Allawi also told us this week that the ITG has yet
to begin to discuss a strategy on approaching Gulf
creditors). Mahdi was planning to meet with Allawi after
Allawi returned from Brazil to "draw up a strategy." Mahdi
hoped the ITG would have a strategy by the end of the month
(May). Mahdi suggested the ITG might use the Brussels
Conference on June 22 as leverage to at least push for
responses from Paris Club members to previous MOF letters
requesting bilateral deals better than Paris Club terms. "So
far no positive responses((they are) all sticking with 80
percent." Mahdi said the ITG would send a "good team" to
Brussels, led by Foreign Minister Zebari and including FinMin
Allawi and Deputy Prime Minister Rowsch Shaways. They plan to
have "something to say on commercial and Gulf creditors,"
according to Mahdi. He expects the ITG to have a "vision of
all the claims" by the end of this year.
-------
COMMENT
-------
¶11. (C) One day after submitting his resignation, Azez was
noticeably more pessimistic about Iraq's progress on key
reforms necessary for the negotiation of a SBA with the IMF,
especially if he was not going to be involved in the process.
Azez said the IMF's invitation to Allawi to participate in
the Article IV consultations June 6-12 in Bahrain stated,
"Azez must come," according to Azez. IMF (non)- resident
representative Ibrahim Tigani called us after hearing of
Azez's resignation to say the IMF is now considering what to
do about the June 6 Article IV consultations. He said the
IMF will probably write to Allawi re-transmitting the
questionnaire that must be completed for the meeting to go
forward. Without Azez in attendance, the ITG will need to
impress upon the IMF during Article IV consultations that
they are capable of providing the data and making the
political decisions necessary to negotiate and fulfill the
commitments associated with a SBA.
Jeffrey